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U.S. Banks Face Tougher Leverage Ratio

Supplemental leverage ratio rule adopted today applies to eight large banks; their borrowing power is more strictly limited than is their overseas competitors'.

The biggest U.S. banks will face greater restrictions on their borrowing power than their overseas competitors under supplemental leverage ratio rules adopted by regulators in Washington today.

Eight lenders, including JPMorgan Chase & Co. and Bank of America Corp., are required to keep loss-absorbing capital equivalent to at least 5 percent of total assets, under the rules designed to curtail risk in the financial system. The requirement approved by the Federal Deposit Insurance Corp. (FDIC) and Office of the Comptroller of the Currency (OCC)—and set for a Federal Reserve vote today—surpasses the 3 percent minimum set in a global agreement by the Basel Committee on Banking Supervision.

“The leverage ratio serves as a critical backstop to the risk-based capital requirements—particularly for the most systemic banking firms—and moderates some of the pro-cyclicality in the risk-based capital regime,” Daniel Tarullo, the Fed governor responsible for financial regulation, said in a statement.

The leverage rule, which also affects Citigroup Inc., Wells Fargo & Co., Goldman Sachs Group Inc., Morgan Stanley, Bank of New York Mellon Corp., and State Street Corp., is meant to work alongside those risk-based capital standards approved by U.S. regulators last year and a pending rule that would require banks to keep a high level of ready-to-sell assets to weather a crisis. Bankers had argued that the leverage demand—often described by the agencies as a backstop—would become the dominant capital standard, and Tarullo agreed today that it will be the most binding constraint for some banks.

Today’s final rule is accompanied by a new proposal to revise the leverage calculations based on an agreement earlier this year by the 27-nation Basel Committee.

Those changes, which will be open for public comment until June 13, will add about 8 percent on the asset side of the ratio, regulators said. That would swell the asset base by 50 percent to about $15 trillion, according to estimates compiled by Bloomberg. The ratio will be measured using daily averages over each quarter.

U.S. regulators developed the rules in response to the 2008 credit crisis that saw the collapses of Bear Stearns Cos. and Lehman Brothers Holdings Inc., and prompted lawmakers to provide billions of dollars in bailouts to keep other big banks afloat. The companies have until 2018 to comply, giving them plenty of time to make up any shortfall.

Most of the banks have said they already or soon will meet the demand for 5 percent capital at the bank holding company level and 6 percent at banking units. The holding companies are about $68 billion short, and the banking subsidiaries face a $95 billion shortfall, regulators said.

Snubbing Treasuries

As they tailor their capital strategies based on the final leverage ratio rule, banks may snub Treasuries and pursue higher-risk assets, according to industry analysts.

“Leverage ratios punish low-risk assets,” Oliver Ireland, a banking lawyer at Morrison & Foerster LLP in Washington, said in an interview. “To the extent that they do a constraining rule, it tends to discourage you from holding things like Treasury securities.”

With four years to comply with the rules, banks will have some flexibility, Coryann Stefansson, a managing director at PricewaterhouseCoopers LLP, said in an interview.

“They’re going to have to be more disciplined with how they allocate capital,” she said. “Firms are spending an awful lot of time trying to minimize the impact while still maximizing your potential profitability.”

Using the Basel agreement for calculating a bank’s assets was a welcome change for banks after the global panel dialed back the approach from a tougher earlier version.

It’s a “less draconian” approach than previously discussed by the international group and met the industry halfway, Stefansson said.

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